One of the entertainments of the holiday period was reading Adults In The Room, the book by Yanis Varoufakis.
It describes his time as finance minister of Greece, and his negotiations with the IMF, the European Central Bank, and the European Commission.
Varoufakis was only in the job between January and July 2015. He had the unenviable task of trying to renegotiate the massive debts of the Greek government.
Reading between the lines, Varoufakis cannot have been an easy person to deal with. Indeed, he was effectively forced out of his position by the far-left Prime Minister Alexis Tsipras.
Still, the academic-turned-politician had many bright ideas. But he could get no traction.
Some of Jeremy Corbyn’s shadow cabinet will undoubtedly have read the book. The more reflective among them will realise that negotiating with international bodies when you have a large burden of public sector debt is not exactly fun. In the end, exactly like the Greeks, you will be forced to adopt policies of austerity which you have spent your political life criticising.
But many of our more ardent Remainers would also benefit from reading the former Greek finance minister’s analysis and descriptions of events.
To them, the EU represents a kind of Garden of Eden, where milk and honey (as well, of course, as sweetness and light) flow in abundance.
The harsh reality is that, in their fanaticism for greater European integration and its crowning symbol of the euro, Europe’s elite are quite unable to get to grips with the fundamental problems which the continent faces.
The financial crisis of the late 2000s began to take hold of the wider economy during the winter of 2007/08. The year 2007 represented for most countries the peak level of output before the crash.
Over the past decade, western European countries in the Eurozone have grown much more slowly than comparable ones which have their own currencies.
Greece, of course, has experienced one of the deepest and longest recessions in the entire history of capitalism. Greek output in 2017 was 22 per cent lower than it was in 2007.
Even leaving Greece out of the calculations, the growth performance of western European economies in the Eurozone has been poor. Their average growth over an entire decade has been just 5.6 per cent.
In contrast, average growth in a group made of the US, Canada, Japan, Australia, the UK, and smaller non-Eurozone countries like Norway and Switzerland has been 16.2 per cent. The UK itself is below the average for this set at 11.4 per cent – still, a lot higher than the Eurozone average.
Towards the end of last year, much was made of the fact the growth in the Eurozone as a whole had slowed from 0.4 per cent in the second quarter of 2018 to just 0.2 per cent in the third quarter.
But Europe’s problems are much deeper-seated. The evidence of an entire decade shows the stultifying impact of the euro. The best decision that Gordon Brown ever made was to keep us out of it. If only Greece had done the same.
As published in City AM Wednesday 9th January 2019
Image: Street Art by Aesthetics of Crisis under CC BY 2.0
In Charles Dickens’ A Christmas Carol, Scrooge finds being haunted by the Ghost of Christmas Past unbearable.
He begs it to stop. The Ghost replies: “These are the shadows of things that have been. That they are what they are, do not blame me.”
It might almost be the Prime Minister speaking about the whole Brexit process.
How might things have been different? And are there any pointers about our future dealings with the countries of the EU?
A fundamental concept in game theory is that of the non-credible threat. This means making a threat in a sequential game – one in which there is a sequence of moves by each side – which a rational player would not carry out because it is not in their interest to do so.
But in order to be effective, the other side has to believe that you will in fact carry it out if necessary.
Donald Trump is a master of making such threats. China and North Korea both respect and fear him precisely because he conveys the impression that he might indeed do something completely irrational.
The UK held – and still holds – two major bargaining chips in the Brexit negotiations: our armed forces (specifically the nuclear deterrent) and GCHQ. But at an early stage, Theresa May ruled out using either of these in the negotiations.
At the moment, for example, British troops are stationed on the border of Estonia and Russia. They have taken part in war games to offer deterrence to Vladimir Putin.
The Baltic states live in fear of a Russian invasion. They all have sizeable Russian-speaking minorities. In 1940, they were taken over by the then Soviet Union, and only regained their independence in 1991.
They may not count for much in EU circles. But Britain could have made it clear that, unless these countries supported us, they would have to rely on, say, the Germans to defend them, and not the UK.
Similarly, GCHQ is acknowledged to be the best cyber intelligence organisation in the EU. The head of the agency said in June that it had played a critical role in thwarting terror attacks in four other European countries in the past year. Letting just one of these attacks go ahead would have brought instant credibility to Britain’s leverage – though it would of course have come with a significant cost.
On a more positive note, a number of EU governments are openly critical, and almost actively hostile, to the European Commission.
Poland, Slovakia, Hungary, and the Czech Republic all have major concerns over migration. Matteo Salvini in Italy has never made a secret of his dislike of Brussels, and since his election has had a fierce argument with the EU over the Italian budget.
But the Prime Minister seems not to have tried to build an alliance with him, nor with these other eurosceptic nations.
Some may argue that these governments are not necessarily in the liberal tradition. They are, however, potential allies. And as the great nineteenth century Prime Minister Viscount Palmerston said: “Britain has no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow.”
If May had heeded this, how differently things might have turned out.
As published in City AM Wednesday 19th December 2018
Image: Theresa May by Arno Mikkor under CC BY 2.0
Economists have long argued that an effective way of reducing carbon emissions is by increasing taxes on energy consumption.
This year’s Nobel laureate, Bill Nordhaus, advocated a global carbon tax over 40 years ago.
The scientific logic is impeccable. But the practical politics of it are fraught with difficulties.
To say that energy taxes, and fuel taxes in particular, are lacking in popular support is to indulge in understatement. President Emmanuel Macron has just tried to increase the price of fuel in France by €0.04 a litre, and the centre of his capital has been put to the torch.
But even we normally placid British, with no revolutionary tradition to compare to that of France, have form on the matter.
Norman Lamont, then the Conservative chancellor, introduced the so-called fuel escalator in his 1993 budget. Fuel duty would increase each year by three per cent more than the rate of inflation. When Labour won in 1997, Gordon Brown put the escalator up to six per cent.
By September 2000, however, enough was enough. Deliberately slow protest driving in towns and on major roads was combined with blockades of oil refineries. Whole swathes of the country were brought to a virtual standstill within a matter of days.
In his pre-budget report in November of that same year, Brown announced that fuel duty would be frozen completely until 2002.
Since then, successive chancellors have approached fuel duty, and especially the escalator, as one might a dangerous wild beast. Occasionally, they have summoned up the courage to give it a gentle prod, and increase fuel duty simply by the rate of inflation. But while the escalator may still exist in theory, in practice it has been abandoned.
Of course, the events in France are driven by more than the now-withdrawn eco-tax on fuel. But it certainly acted as the key trigger to the demonstrations, which have enjoyed widespread support across the country.
No doubt many of the sympathisers dutifully organise their recycling into the appropriate bins. The seeming plethora of extreme weather events this year will have encouraged this bourgeois sense of duty to do something about climate change.
Yet when it comes to being required to part with some actual cash in the form of a fuel tax, which is a more effective way of curbing emissions, they become enraged. They know that climate change may well impose large costs in the future, but they are unwilling to pay a small cost now to help reduce them.
Behavioural economics provides the key to understanding this seemingly paradoxical behaviour. One of its strongest empirical findings is that, when trying to compare future costs and benefits with those on offer now, people often use “hyperbolic discounting”.
Translated, this simply means that they place far more value on small rewards or costs which are incurred now than on much larger ones in the more distant future.
It is unlikely to comfort Macron to know that the French riots can be ascribed, in part, to hyperbolic discounting. But the rest of us might enjoy a good laugh.
As published in City AM Wednesday 12th December 2018
The Bank of England and Federal Reserve held a two-day conference last week in London on big data and machine learning. All very interesting stuff.
There was an intriguing vignette as we emerged from the conference room for the frugal lunch on the first day.
Straight ahead was a table with sandwiches, fruit and the like. Most participants made for this, so many that a long queue soon formed, stretching well out of the room. But a sharp right instead brought you to a smaller table, with identical food. The wait was very much shorter.
This illustrates important aspects of modern economic theory.
In fashion markets and on the internet, for example, products or sites can rapidly become popular for reasons not connected to their inherent qualities. They become more popular simply because they are already popular. People start to follow the crowd rather than rely on their own judgment.
The same thing can be observed in bubbles in financial and property markets. An extreme example was seen in the case of Northern Rock in the run-up to the financial crisis in 2008. The bank did in fact have enough assets to pay its liabilities. But it experienced a short-term liquidity problem and approached the government for support.
The news leaked, and within 24 hours huge queues formed outside the branches as people scrambled to get their money out. The longer the queue, the bigger it became. The result was the first bank failure in the UK for 150 years.
This herd-like behaviour seems irrational. But an important paper by Sushil Bikhchandani and colleagues in the top-ranked Journal of Political Economy 25 years ago showed that it was perfectly compatible with the economic concept of rationality.
Suppose you have to make a decision, like the table to go to in order to pick up lunch. You might have some private information about the options. In addition, there is some public information available to all.
If enough people have chosen and have already given more weight to the public information, it will seem like it is more accurate than your own. So you are likely to give more weight to it when you choose.
This is exactly what happened at the central bank event. The first few people coming out of the conference used private information, and made for the table they could see. Others behind them could only see people getting lunch, and simply followed them. They used the public information about where lunch was available.
Those in the long queue had imperfect information, another key concept in economic theory. They were outside the room and could not see the other table in the opposite corner.
I considered approaching people in the queue to sell them information to shorten their wait. But it is a bit tricky to value information – yet another important issue in modern economics. As soon as I mentioned it, they would easily guess there was another table and find it themselves.
The conference itself was fascinating. But it was certainly gratifying to see economists behave as rational herders.
As published in City AM Wednesday 5th December 2018
Image: Northern Rock by Alex Gunningham via Wikimedia under CC BY-SA 2.0
The Economic Statistics Centre of Excellence created a bit of a stir at the end of last week with its estimates of growth in the regions of the UK.
Since the recovery from the financial crisis began during 2009, London’s economy has grown by 26 per cent.
At the other end of the scale, output in the north east has expanded by only six per cent, less than one per cent a year. Yorkshire has grown by just eight per cent, and the north west, which includes both Liverpool and Manchester, by 11 per cent.
The economies of the Eurozone show a similar pattern. Since 2009, Germany has expanded by 20 per cent, growth in Spain has only been six per cent, and the numbers for Portugal and Italy are even lower, at just two and one per cent.
The regions of the UK and the Mediterranean economies of Europe have an important feature in common: both groups are in a monetary union with more dynamic and innovative economies. Newcastle is in the sterling monetary union with London, and Portugal is in the euro with Germany.
The weaker economies are not sufficiently competitive to produce enough goods and services that others want to buy. They run a balance of payments deficit with the world outside their borders.
And in a monetary union, a balance of payments deficit translates into lower growth and higher unemployment. Standard trade theory in economics shows this clearly.
At least in the UK, the poorer regions get compensation in the form of large transfers of money from the more successful ones to finance their trade deficits.
London generates a fiscal surplus – the difference between income raised by taxes and public spending – of £3,700 per head, according to the latest Office for National Statistics estimates. But only two other regions – the south east and the east of England – run surpluses. The rest are in deficit – they spend more than they raise in tax.
Northern Ireland gets the biggest per capita subsidy, to the tune of £5,000 a year for every single person living there. The DUP might usefully contemplate the fact that the rest of us would be better off if we got rid of the province altogether.
A devaluation for the UK’s regions against London and for the economies of southern Europe would help to make them more competitive. In a monetary union, this is simply not possible.
The problem goes deeper than a simple lack of price competitiveness. The British regions just do not attract enough high-skilled workers to produce the quality goods and services which are in demand in the twenty-first century.
We might imagine that low housing costs would attract people, but the price mechanism works very slowly and imperfectly in this context. Over the past couple of years, there has been a trickle of people out of London to the regions, while the inflow from them to the capital has been halted. But there is a long way to go.
And that means that, whatever form Brexit takes, the economic trends of Britain’s monetary union are such that the future for Britain’s regions still looks grim.
As published in City AM Wednesday 29th November 2018
Image: Derelict Factory by Will Lovell via Geograph under CC BY-SA 2.0
The shambles that is Network Rail continues to blight our lives.
City A.M. readers may have experienced the cancellation of many services into Waterloo on Monday, due to engineering works overrunning. Even the best-laid plans can go astray. But this week was not just a one-off event. It seems to be a permanent feature of life under Network Rail.
The old Eurostar platforms at Waterloo are being redeveloped for use by regular trains. The work seems to have been going on since the Norman Conquest, and still only one platform is in operation.
And disruption is not confined to Waterloo. Back in May, the introduction of new timetables across the UK’s rail network created chaos.
On 27 July, the Office of Rail and Road (ORR) wrote to Network Rail and said, according to its website: “we had concluded that Network Rail are in breach of the timetabling conditions in its network licence”.
What could the regulator do about the breach? First, the ORR could improve its grammar and decide whether Network Rail is plural (“are”) or singular (“its”). But this aside, the answer is: not much. Because Network Rail is a nationalised industry.
You might hope that the train operating companies, with their private sector dynamism and innovation, should be able to overcome these challenges. But the basic problem is that many of the operating franchises are now run by foreign state-backed companies.
Their names may not be on the side of the trains themselves, and the precise pattern of ownership is often complex. But Deutsche Bahn, in which the German government is the majority shareholder, owns the outfits which run franchises such as CrossCountry. The French state operated company SNCF lies behind franchises like the Gatwick Express. Abellio, run by the state-owned Netherlands Rail, operates the Greater Anglia franchises.
Britain’s railways have evolved into a system which is run and maintained by state-owned companies. There is relatively little genuine private sector involvement.
Initially, rail privatisation was a great success. The peak number of passenger journeys made each year was some 1.1bn in the mid-1950s. This fell to 750m in the 1990s. Then, after privatisation began, there was a dramatic reversal, as the new private companies paid more attention to consumers. Journey numbers started to rise, passing the one billion mark in 2003, to the current level of 1.7bn.
However, with the increasing involvement of companies which are ultimately backed by the taxpayer, whether British or foreign, interest in the wellbeing of rail users – the consumers – has declined.
Many of our major routes, whether commuter or long distance, are operating close to full capacity. There is less incentive either to treat people well or to attract more passengers.
The Labour party routinely calls for the nationalisation of the railways. But to all intents and purposes, they have effectively become nationalised already.
As such, the industry offers not just a glimpse, but a full-length feature film on what life would be like in general under a government led by Jeremy Corbyn – cancelled trains to Waterloo are just the start.
As published in City AM Wednesday 21st November 2018
Image: Waterloo Station by Ben Brooksbank under CC BY-SA 2.0
A visit to Rochdale Sixth Form College was a cheering experience last week.
This year, 55 per cent of A-levels were at grades A* to B.
True, Eton and Winchester do better. But this track record shows that even poor boroughs – and Rochdale is one of the poorest – have the capacity to deliver high-quality education with good leadership and teaching.
I gave a talk to over 200 A-level students of economics and computer science. They were a lively bunch who asked interesting questions. But the most fascinating piece of information I obtained was in the informal discussions afterwards.
Literally none of these 16-18-year-olds was on Facebook. They all used other apps to communicate with each other and share stories.
Globally, of course, Facebook continues to grow. The latest statistics give the site 2.27bn users who are active at least once a month. This is an increase of some 10 per cent compared to a year ago.
To set against this, it was only just over three months ago that Facebook suffered the biggest one-day loss in the history of Wall Street. The company’s shares dropped nearly 19 per cent.
This appears, with the benefit of hindsight, to have been due to a perception among investors that the reported growth in users was below expectations.
The biggest demographic of users is the 25-34 age group. But right in front of me was a group of bright young people from the demographic immediately below this. And there were no Facebook users.
A powerful way of understanding how things spread on social networks is based on work by the Scots Anderson McKendrick and William Kermack in 1927. This pioneered the mathematical analysis of how epidemics either spread or are contained in a population.
There is now a huge and complex body of scientific literature built on these foundations. But a fundamental point remains: for an epidemic to be sustained, a supply of new people who are susceptible to it is necessary. Otherwise, it eventually fades away.
A related problem seems to confront Apple. The tech company’s shares fell seven per cent in a single day last Friday, on fears that iPhone sales have peaked. In other words, the number of people buying the new models has plateaued – at best.
Apple’s chief executive, Tim Cook, warned that sales for the Christmas trading period could fall short of Wall Street’s forecasts.
What made the markets even more nervous was the announcement from the company that it would stop publishing the volumes of phones, tablets, and laptops sold. Apple has provided this information during its period of spectacular sales growth over the past 20 years.
Among the students I met, so-called “dumb phones” are rising in popularity. These are designed just to make calls and send texts.
The tech giants are increasingly seen as dangerous monopolies. But in an evolving market economy, even the biggest firm will eventually fail. The Rochdale students could well be revealing the future.
As published in City AM Wednesday 14th November 2018
From discussions on how the UK should reform its tax and regulatory landscape to make the most of post-Brexit opportunities, to the rallies midterm election candidates have been holding across the US championing or lambasting the President’s tax cuts, the debate is still raging about how changes to taxes impact economies.
But if you need convincing, or even if you’re just curious, events across the Atlantic provide a natural experiment in which we can observe in real time the effects of big tax cuts on an economy.
Nearly a year ago, on 22 December 2017, President Donald Trump signed the Tax Cuts and Jobs Act (TCJA), the most sweeping revision of US tax law since the Tax Reform Act of 1986.
Since then, economic growth has gone up. Between the fourth quarter of 2016 and the fourth quarter of 2017, GDP grew by 2.5 per cent in the US. In each quarter since, the annual growth rate has accelerated. The provision estimates for the third quarter of 2018 – the latest we have – suggest growth is now three per cent.
The jobs market is also booming. In the year to October, employment rose by over 2.5m. In that month alone, there was a rise of 250,000 jobs on the previous month.
Of course, all sorts of things can contribute to a strong economy. The headline figures simply support rather than confirm the narrative that tax cuts work.
A paper published this week in the leading Journal of Economic Perspectives focuses specifically on the corporate tax changes in Trump’s TCJA.
Beginning in 2018, the federal corporate tax rate fell from 35 per cent to 21 per cent, some investment qualified for immediate deduction as an expense, and multinational corporations faced a substantially modified treatment of their activities.
Alan J Auerbach of Berkeley sets out a detailed theoretical and empirical analysis of the Trump legislation. He is careful to qualify his findings with the usual kind of academic hedges. But they are unequivocal: tax cuts work.
The loss of revenue to the government of the various corporate tax changes in 2020 is estimated to be some $130bn. What will companies do with this money?
Auerbach concludes that at least a half of this will go on increases in wages. There are some 125m families in America, and on average they will be at least $500 a year better off.
Much of the rest will be spent on additional investment, which will further stimulate the economy.
And Auerbach cites a paper by the Harvard economist Robert Barro, due to be published in the Brookings Papers series, which suggests that the impact of the tax cuts will be even higher.
Leading American economists writing in leading academic journals are examining the Trump corporate tax cuts. They are concluding that everyone – both the companies and their workers – benefits from them.
Perhaps Philip Hammond should take a break from his spreadsheets and catch up with his reading.
As published in City AM Wednesday 7th November 2018
Image: Statue of Liberty by National Park Science
The focus this week has been on Philip Hammond’s Budget.
The opinions of the shadow chancellor have been rather in the background by comparison.
But John McDonnell is doing us all a favour at the moment. He is busily promoting a collection of essays which he edited, under the title “Economics for the Many”.
These cover a wide range of policy areas, and are written by a mixture of politicians, think-tankers, and academics sympathetic to the shadow chancellor. The book contains a substantial introduction by McDonnell himself, and so is a useful guide to his thinking.
McDonnell appears to believe that spending vast amounts of money on nationalising industries will cost the taxpayer nothing.
From a balance sheet perspective, this is technically correct. The government could issue debt to take over the rail companies, say, but this would be balanced by the value of assets acquired.
This misses the point. If someone were mad enough to lend you £10m to buy a house valued at that amount, your household balance sheet would not have changed. But how would you service the debt, and what rate of interest would you be required to pay?
The rate of interest on UK government bonds is currently low, at around 1.5 per cent. But this is determined by the markets, not by government diktat. If the markets lose confidence, the rate can change rapidly. In recent years, Italy, Spain and Portugal have all seen rates in the six to eight per cent range. And in Greece, they were as high as 23 per cent.
McDonnell is silent on how he would ensure that the same thing would not happen here.
Some of the essays in his edited volume share this silence. One of them, somewhat ironically, points out the dangers of debt levels being too high. Admittedly this refers to household debt and not public sector debt, but no recommendation is made on how the problem can be solved.
In the same way, several contributors attack the discipline of economics. We read, for example, that it needs to be “more diverse and representative of the society it serves”. Yet no argument is put forward which offers a scientifically superior explanation of events to that of standard economic theory.
To be fair, most of the essays do put forward proposals. But the striking feature is not their radicalism – it is how dull and unimaginative they are.
So, for example, when new firms are launched based on new technologies, they should be set up as cooperatives. Cooperation as a form of business model has been around since the Rochdale Pioneers in 1844. It has not exactly set the world alight.
There is much talk in the media about how Jeremy Corbyn’s Labour party has captured the zeitgeist. This is not reflected in the opinion polls, where the Tories remain obstinately in the lead.
But if it has, these essays suggest that we are not in for an exciting and innovative future. Rather, we will be condemned to a repeat of the dismal and depressing 1970s.
As published in City AM Wednesday 31st October 2018
Image: John McDonnell by Rwendland via Wikimedia is licensed under CC BY-SA 4.0
The media seems full of gloom at the moment. Chaos over Brexit, Saudi Arabia, potential nuclear escalation between the US and Russia – you name it, people are worried about it.
A ray of light is shone – an apt phrase as you will see – by the work of Bill Nordhaus, a Yale economist who was the co-winner of this year’s Nobel prize in economics, along with Paul Romer.
Over the past two decades or so, Nordhaus has worked mainly on integrating climate change into macroeconomic models, and was awarded the accolade for this research. He is no knee-jerk lefty in this respect. For example, he was a prominent critic of Nick Stern’s report on climate change, which was commissioned by Gordon Brown.
But in my view, Nordhaus should have been awarded the Nobel prize years ago for his brilliant work on measuring how well-off we all are.
The conventional measure of GDP per capita is widely criticised these days. But instead of just whinging from the sidelines about how economics is wicked and useless – sadly a common feature in modern critiques – Nordhaus actually tried to do something about it.
In 1972, he and James Tobin (another future Nobel laureate) developed the Measure of Economic Welfare. The two economists took GDP as their starting point. They adjusted it to include, for example, an assessment of the value of leisure time and the amount of unpaid work in an economy.
Taking these factors into account means we are better off than the conventional GDP measure suggests.
The most dramatic paper by Nordhaus, published in 1996, is on the seemingly obscure topic of the history of lighting. He analysed the topic over a vast time span, from the first sources of artificial light – the fires used by humanity around one million years ago – to the modern fluorescent bulb.
The focus of the paper was not the technology as such, but whether the standard ways of measuring the price of lighting captured the massive improvements in quality which have taken place, particularly in the twentieth century.
Nordhaus concludes that the traditional price indexes of lighting vastly overstate the increase in lighting prices over the last two centuries relative to quality. So the true rise in living standards has consequently been significantly understated.
The magnitude of the difference is vast. Nordhaus estimates that the price measured in the conventional way rose by a factor of between 900 and 1,600 more than the true price.
Bodies such as the Office for National Statistics receive information about the economy in current prices. If output in any particular sector has increased, a key task for them is to decide how much of that is due to a rise in prices and how much to a genuine increase in output.
Rapid quality change means that the conventional ways of doing this simply cannot cope. Price rises are overstated, and in consequence “real” changes in output and living standards are understated.
The implication of the apparently esoteric work Nordhaus did on lighting is that modern technology such as the internet has increased living standards far more than the official statistics indicate. Finally some news to be cheerful about.